Cutting Taxes in a Depression is Like Pushing on a String

BC Liberal leader Andrew Wilkinson today announced a plan to completely eliminate the provincial sales tax (currently 7%) for 1 year, and then cut it by 4 points (or 57%) after that. Conservatives are prone to make expensive tax cut promises during elections, a tendency which contradicts their other touch-stone of perpetually promising to get tough on deficits and debt. Like other governments, BC is already facing enormous deficits for years to come as a result of the COVID-19 pandemic and associated recession. While it might be hypocritical for deficit-phobic conservatives to argue for tax cuts even in the face of deficits, it has never stopped them before. So Wilkinson’s gambit should not be surprising. But by pledging to completely eliminate the province’s 2nd largest source of tax revenue, he surely gets high points for sheer audacity.

[For international readers who might not know, British Columbia’s Liberal party is the main right-wing party in provincial politics — etymologically equivalent to Australia’s “Liberals”.]

The 2020 provincial budget forecast that the PST would raise $7.9 billion in the 2020 fiscal year, rising to $8.2 billion in 2021 and $8.6 billion by 2022. So the Liberals’ costing seems too low. They say their plan would cost only $6.9 billion in year 1, $3.9 billion after. It seems to me it should be more like $8 billion in year 1 (depending when the one-year cancellation starts: I assume it would be as soon as possible after the election), and $4.5-5 billion/year after that (and rising over time with inflation and economic growth).

The Liberal costing seems to be based on the government’s 1st-quarter fiscal update, which projects $6.88 billion PST revenue for fiscal 2020-21 (a year which will be two-thirds over by the time the next government takes office). That update makes no projection for PST revenue in 2021-22. The Liberals’ year 1 cost estimate (for a 12-month period that presumably can’t begin until, say, January 1 at the earliest, by the time legislation is passed and tax collection procedures adjusted) is thus based on a lagging 12-month period that includes the worst months of retail shutdown. But the next 12 months won’t remotely resemble that period, even with a second wave of COVID. In fact, BC retail sales have already fully recovered, and in July surpassed their pre-COVID February peak by 2%. So their year 1 estimate is definitely low.

Their year 2 estimate seems to be based on 4/7 of their year 1 estimate (since they are reducing the PST, for that year, by 4 of its 7 points): 4/7 of $6.88 billion = $3.93 billion, exactly what they say it will cost. This estimate is doubly wrong. First, the impact of the March-May retail shutdowns will be even further in the past by 2022 (the soonest that this second year of their plan could apply). And normal economic growth, population growth, and inflation will have boosted the PST base significantly in the meantime.

In that light, the forecasts for PST revenue (with a 7% rate) for 2021, 2022, and even this year from the provincial budget are likely still reasonable. Of course, the pandemic has created big uncertainty around all of those forecasts. But I think it is safe to conclude that the Liberals are low-balling the true cost of their measure by at least $1 billion in year 1, $750 million in year 2, and larger amounts in subsequent years.

The Liberal documents do not indicate when the tax would snap back to 7% (if ever). Suffice it to say that pressure against reversing the rate reduction will be immense. Past experience in many jurisdictions indicates tax cuts have a ratchet effect: once they are in place, they are very hard to reverse. So the Liberal proposal should be interpreted as permanently reducing (or even eliminating) the PST — with implications for provincial budgeting that will last for decades.

In year 1, the Liberal plan would thus increase the provincial deficit (currently projected to reach $12.8 billion for the 2020-21 fiscal year) by over half: to something like $21 billion. I am not averse to larger deficits to spur post-COVID reconstruction, but we need to be sure we’re spending the funds well, and getting the most bang for the buck for fiscal investments made.

It’s hard to accept that sales taxes are somehow holding back economic recovery in Canada: a lack of income, employment, and confidence is the problem. Canadians are actually saving their income at a record rate. The personal saving rate reached 28% of disposable income in the 2nd quarter of 2020. That’s the highest on record, and ten times the usual personal saving rate (which has been around 3% in recent years). Those precautionary savings reflect a deep and justified fear of the future: for both epidemiological and economic motives. Of course, personal savings (even at this inflated rate) are concentrated among the higher-income households who have lost less work and income from the pandemic. (As David Macdonald shows, the highest income decile of Canadians has lost virtually no work or income under COVID.)

In this depressed context, where Canadians are already socking away close to 30 cents of each dollar of disposable income, eliminating sales tax is like pushing on a string. And Wilkinson’s proposal is a very expensive string. Lower sales taxes will not spur COVID-fearing Canadians to suddenly rush to the malls. It would be much more effective to boost employment, incomes, and confidence through direct spending programs.

It is interesting to note that growth in BC’s retail sales has been much stronger than the Canadian average. BC retail sales grew by 2.1% in July (seasonally adjusted), over 3 times faster than in Canada as a whole (which were up 0.6% in July). On a year-over-year basis, BC retail sales grew 5.7% to July (vs. 2.7% for Canada). BC’s sales tax is the 3rd lowest in Canada to start with (after Alberta, with none, and Saskatchewan at 6% — tied with Manitoba at 7%). The tax is clearly not holding back a recovery in retail sales here, which now exceed their pre-COVID peak (set in February) by 2.3%.

Speaking of Alberta, it is interesting to compare retail sales in BC to Alberta (which, with no provincial sales tax, is presumably the BC Liberals’ role model). BC’s monthly sales growth was almost twice Alberta’s in July. Year/year sales growth to July was 3.5 times better than Alberta’s. Yes, Alberta has many unique problems which have affected retail activity there (not least being that province’s less effective strategies to control the spread of COVID-19). But the absence of a provincial sales tax clearly hasn’t helped Alberta, whose economic challenges are significantly worse than BC’s.

On the distributional side, sales taxes are mildly regressive, so cutting them could be seen as mildly progressive. The BC Liberals are certainly playing up this angle, but their sudden concern for progressivity doesn’t fit well with their overall worldview — such as their strident opposition to high personal income tax rates for high-income individuals. But even with a flat-rate sales tax, rich people still get enjoy far larger absolute tax savings than low- and middle-income people — for the simple reason that they spend many times more income on consumer goods and services. And the distributional impact of the PST cut cannot be considered separately from the effects of corresponding program spending. The net combination of raising revenues through a sales tax and spending it on public programs (which generally have strongly progressive distributional effects) is definitely progressive. It is safe to assume that the PST cut (or even elimination) will inevitably be accompanied by spending cuts, which a future conservative government would justify as being necessary to tame the deficit (which they themselves helped create). The overall impact of this strategy is therefore highly regressive.

Here’s a cartoon from my Economics for Everyone, penned by the great Tony Biddle, which summarizes this tried-and-true conservative game plan:

In depression-like circumstances, boosting spending is the critical task of macroeconomic policy. Tax cuts are never as effective as direct spending in this regard, because so much of the stimulus leaks out in savings. This leakage is extraordinary at present, as confirmed by the astronomical surge in the personal saving rate. There are far better ways to spend $8 billion & spur more genuine & lasting economic recovery in BC, including:
* rapidly expand affordable child care (with multiple economic benefits, including facilitating women’s employment recovery)
* accelerate physical & social infrastructure projects
* build non-market housing (creating jobs now, and alleviating one of BC’s most pressing economic problems, overpriced housing, in the long-run)
* partner with municipalities to retain vital services that are being cancelled because cities are not allowed to run deficits.

Tax cuts are ineffective and regressive. This one is also enormous, and would have lasting negative impacts on the provincial government’s capacity to fund essential services and programs that are critical to the quality of life in this province.